ALFI responds to the FSB Consultation addressing Structural Vulnerabilities from Liquidity Mismatch in Open-Ended Funds

ALFI responded to the FSB Consultation on Structural Vulnerabilities Arising from Liquidity Mismatch in OEFs. This consultation coincided with the IOSCO consultation report on Anti-dilution Liquidity Management Tools, aiming to provide guidance for the effective implementation of liquidity risk management recommendations for CIS (see ALFI’s corresponding response in eventid=22788).
ALFI appreciates the principle-based guidance that promotes convergence and good practices while allowing flexibility for fund managers to design and implement liquidity arrangements based on individual case assessments. ALFI emphasizes the fund manager’s primary responsibility in selecting appropriate liquidity management tools, raising concerns against prescriptive approaches like systematic bucketing and mandatory market impact inclusion in anti-dilution techniques.
Bucketing Approach Critique:
ALFI argues against the bucketing approach, as it lacks effectiveness due to the dynamic nature of liquidity, model risks, and asset-specific liquidity idiosyncrasies. A principle-based framework focusing on contingency planning is recommended to mitigate liquidity mismatch risk. ALFI suggests a toolbox approach with various tools to handle unforeseen situations.
Model Risk Concerns:
ALFI highlights the challenges in categorizing assets as „liquid,“ „less liquid,“ or „illiquid“ based on convertibility and price impact, as these elements are non-observable. Models used for estimation depend on assumptions and incomplete data, resulting in uncertainty. Diverse models in liquidity measurement yield diverging estimates, making a strict categorical classification unfeasible.
Time-Varying Liquidity Dynamics:
ALFI points out that the bucketing approach assumes constant liquidity, which doesn’t reflect the reality of fast-changing asset liquidity profiles, especially during market shocks. This quasi-static approach fails to capture evaporating liquidity, defeating its purpose.
Incentives and Unintended Consequences:
ALFI anticipates divergent classifications under the bucketing approach, potentially creating negative incentives for less conservative liquidity estimates. In contrast, principle-based frameworks encourage unbiased assessments, supporting effective decision-making.
Broader Asset-Liability Liquidity Matching Tools:
ALFI suggests that the current proposal mainly relies on dealing frequency, notice period, and anti-dilution tools, ignoring the broader toolbox used by managers to handle different market conditions and asset classes, especially for less liquid asset types like Real Estate funds.
Stress Testing:
ALFI acknowledges the importance of stress testing but recommends adopting a principle-based approach and not embedding stress testing into prescriptive rule-based methods like bucketing due to uncertainties and unprecedented nature of liquidity stress events.
Thresholds Critique:
ALFI argues against the use of prescriptive thresholds, highlighting their arbitrary nature, the absence of universal thresholds, and the potential for cliff edge effects. Prescribed thresholds may not adequately address mismatch vulnerabilities.
Market Impact Inclusion:
While recognizing the value of including significant market impact in anti-dilution tools, ALFI emphasizes the need to assess whether it can be estimated accurately and at a fair cost to investors. This decision should be the manager’s responsibility based on a cost-benefit analysis.
Principle-Based Approach:
ALFI supports a principle-based regulatory framework that accommodates industry diversity while promoting convergence and flexibility.
Differentiation between Subscriptions and Redemptions:
ALFI suggests allowing investment managers to apply different treatments for subscriptions and redemptions, considering their distinct characteristics and impacts.
Transparency:
ALFI supports transparency but advises against full public disclosure of detailed anti-dilution tool activations, as it may lead to negative consequences and exploitation of information.
Objectives of Anti-dilution Tools:
ALFI emphasizes that anti-dilution tools primarily aim to protect investors from dilution, rather than stabilizing financial markets. Prescriptive rules should not hinder investors‘ access to capital, and liquidity management frameworks should strike a balance between liquidity and costs.